POLITICAL UNCERTAINTY PRESENTS CURRENCY RISKS

May 26, 2017

Emmanuel Macron’s victory in May’s French presidential elections was hugely welcomed by the currency markets which breathed a sigh of relief when he prevailed against the challenge of the anti-EU Front National.

While the Pound continues to languish with Brexit uncertainty still hanging over Britain, the Euro, at least for now, is not about to be subjected to political turmoil.

It must be acknowledged that the French elections did not have an overall positive impact on European markets. After a brief rally in which it hit a six-month high against the US Dollar, the Euro fell back in value, France’s CAC 40 index closed down 0.9 per cent and Germany’s DAX dropped 0.2 per cent immediately after Mr Macron’s victory. This was possibly a reflection on the fact that he is a political outsider who is yet to be tried and tested. The potential for much more severe market reaction from a Le Pen victory, however, was at least averted.

WithFrench and Dutch elections so far delivering relatively stable outcomes in terms of their impact on the markets and currency valuations, how do we assess prospects for the remainder of the year with the UK facing Brexit and Germans set to go to the polls in September?

Following last year’s vote to leave the European Union, UK businesses had to quickly come to terms with the fact that Sterling sank by 20 per cent against other major currencies. A year later the Pound remains low. As Britain begins to negotiate its terms of departure from the EU, there is, according to many leading currency strategists including Deutsche Bank’s George Saravelos, potential for a further drop in value.

Despite the rejection of anti-EU parties in France and the Netherlands, there are still threats hanging over the future value of the Euro as an anti-EU mood continues to grow in some parts of Europe. While this isn’t anywhere near the same scale as wesaw in the UK in the lead up to the 2016 EU referendum, events in the year ahead could still prove significant in determining the longer term fate of the single currency.

Germany’s elections will be held on 24th September with Angela Merkel running for her fourth term. This election comes at a challenging time for the Chancellor and her Christian Democratic Union (CDU) party. The refugee crisis in 2015, which saw Germany welcome 1.1 million people from countries like Iraq, Syria and Afghanistan, has been followed by some high profile terror incidents in the country which have thrown into question whether Ms Merkel will remain as Germany’s leader. She did, however, receive a recent boost when the CDU won regional elections in North Rhine-Westphalia, an area which traditionally votes for their Social Democratic Party (SPD) rivals. Reports of Ms Merkel’s demise could therefore be over-exaggerated.

The forthcoming national contest now looks set to be a fight between Merkel’s centre-right CDUand Martin Schulz of the centre-left SDP. While The far-right and anti-European Alternative für Deutschland (AfD) party saw its vote squeezed in the recent regional elections, there’s still time between now and September for unanticipated events to shape the outcome of these nation-wide elections. Should more radical parties like AfDgain further traction, it could significantly impact the stability of the single currency.

The unfolding scenario in Europe presents a challenge to any businesses transacting in Pounds and Euros. We are facing at least two years (and likely more) of Brexit negotiations, which will impact both the British and European economies. The German elections, while currently looking likely to produce a Chancellor from a mainstream party, could yet throw up a few surprises which affect the markets. They will, in any case, very likely have an impact on currency markets, one way or another. Let’s also not forget the very real potential for the US Dollar to fluctuate significantly over the course of Donald Trump’s Presidency.

The potential for fluctuations in currency values is, of course, not always detrimental to business. It can present a threat as well as an opportunity for importing and exporting companies, depending where they conduct their operations and how well-prepared they are to capitalise on a rise or drop in currency value.

In a climate of uncertainty, such as we are currently experiencing, it is vital that companies implement a robust and comprehensive risk-management strategy to minimise their exposure to foreign currency movements which often result from political uncertainty.

Businesses with foreign currency requirements, especially those which trade across the UK and within EU nations, need to look at how they can best conduct their transfers strategically to manage their exposure and secure profitability. The starting point for developing such a strategy is to clearly understand what their level of exposure is in terms of currency movement. From there they can set out an appropriate budget rate and create a suitable hedging plan. Using a combination of forward contracts, spot deals and orders according to such a strategy can provide certainty and protection, shielding their bottom line and maximising the funds they receive.

As we saw with the UK’s EU referendum, the business community will have little impact on the outcome of forthcoming political events but companies can ensure they areas well prepared as they can be. This will help them mitigate risks and seize any potential opportunities that may result from further currency fluctuations that lie ahead.